Recently the Illinois Supreme Court unanimously rejected legislative pension reform, ruling that the 2013 legislation violated pension protections written into the state’s Constitution. Illinois’ Constitution provides that benefits promised as part of a pension system for public workers cannot be diminished or impaired.

With a pension shortfall estimated at $111 billion, Illinois has struggled to address its staggering $2 billion budget deficit for the coming fiscal year. Future years don’t look any better. Noting the state’s financial circumstances, the Illinois Supreme Court held that dire fiscal challenges were not enough to modify pension benefits protected by the state’s Constitution, stating:

The financial challenges facing state and local governments in Illinois are well known and significant. In ruling as we have today, we do not mean to minimize the gravity of the state’s problems or the magnitude of the difficulty facing our elected representatives. It is our obligation, however, just as it is theirs, to ensure that the law is followed. That is true at all times. It is especially important in times of crisis when, as this case demonstrates, even clear principles and long-standing precedent are threatened. Crisis is not an excuse to abandon the rule of law. It is a summons to defend it..

Opinion at 35.  Or, maybe it is time to apply federal law.

Can this opinion be squared with the state’s police powers to modify contractual obligations when it is necessary to protect the general public welfare?

Not easily if you look at federal case law. More easily if you limit the analysis to Illinois case law. According to the Illinois Supreme Court, the legislative history surrounding the 1970 Constitution shows that the drafters failed to specifically provide that the pension protections were to remain subject to the authority of the State to step in when public safety and welfare so required. The Court concluded that without an express reservation of police power authority, the State could not adjust constitutionally protected pension benefits through legislation.

The Illinois Attorney General argued that this analysis is backwards. The applicable doctrine requires that if exercise of police power is to be limited, it must be done so in clear, unambiguous and explicit language. The legislative history is silent on this matter and under federal case law exercise of a state’s police power cannot be so easily set aside. In fact, the U.S. Supreme Court has consistently ruled that states cannot abdicate their inalienable governmental power to provide essential services. This means that, at least on a federal level, a state’s constitutional contract clause and the Contract Clause of the U.S. Constitution do not prevent or preclude the state’s exercise of police power.

One could describe the Illinois Supreme Court’s ruling as through the “Looking Glass” of Illinois law. The Court gave short shrift to federal case law and well-established U.S. Supreme Court authority that establishes that no contract right, even a constitutionally protected right, is absolute. And, if a state needs to assert its police power to impair contracts in order to deliver essential services, at least under federal case law, a state has the option of presenting the evidence necessary to establish the appropriate use of police power.

What does this mean for Illinois?

Nothing good. Two opinions later, when one considers the lower court and the Supreme Court, Illinois’ police powers are pretty much nullified with regard to pension reform. Illinois is left with two options. Option one is asking the U.S. Supreme Court to review the Illinois Supreme Court opinion. Of course, seeking a writ of certiorari is a bit like playing the lottery. No doubt there are many different opinions about whether the U.S. Supreme Court would grant cert.

Option two is the Governor’s immediate call for a constitutional amendment to clarify the distinction between guarantees of benefits already earned and changes to future benefits. There seems to be some sense that a constitutional referendum can be successfully passed by the voters to amend the same pension protections the Illinois Supreme Court just enforced. Here’s hoping that Governor Rauner picks up the phone and talks to Chuck Reed, the former mayor of San Jose and a lead proponent on multiple initiatives to deal with California’s vested pension benefits. Mayor Reed and his dedicated team have been up to bat at least twice and are working on a third option. It’s not an easy process and experience is showing it will require years of consensus building with voters and political hurdle jumping. A constitutional amendment may not be in Illinois’ immediate future, but it can’t hurt to start the dialogue.

So what about bankruptcy? Not for Illinois.

Governor Rauner told a number of news agencies that if Illinois were a corporation, it would probably need to file for bankruptcy. Since Illinois is a state, it does not have access to Chapter 9. As a result, Illinois is in between a rock and a very hard place with no wiggle room.

Yes, there may be options, other than pension reform, as the Illinois courts suggested, and the evidence showed, the legislature considered these options. But looking to other options when the largest liability is pensions and Illinois’ state pension system is in jeopardy is akin to putting a single finger in a rapidly disintegrating dam.

The state’s other options are somewhat limited when considered in light of the multi-billion dollar pension liability: reduce costs, reduce the number of state employees, reduce state services and increase taxes. State employees will have to do more with fewer employees and taxpayers are going to pay more for less. The state also has the option of developing medium and long-term plans that would allow it to evaluate public to private partnerships that could be used to generate liquidity and reduce debt. Growing the top line should not be ignored, despite the challenges.

While no one wants to cut anyone’s pension, the idea that a program as simple as reducing COLA’s, changing retirement dates and capping extremely high pensions cannot happen in tandem with other reforms is nothing short of mind boggling.

Illinois Chapter 9 Legislation – General Assembly Bill HB0298

Nonetheless, Illinois can provide access to Chapter 9 bankruptcy to its municipalities and that is exactly what proposed General Assembly Bill HB0298 does. It provides simply that “any municipality may file a petition and exercise powers pursuant to applicable federal bankruptcy law.”

Several hearings have been held and the State has been provided with a host of suggestions regarding the need for circuit breakers to prevent unprepared municipalities from free fall filings and never-ending bankruptcies. HB0298 has been stuck in the Rules Committee since March 27, 2015, if the Illinois General Assembly site is current. Nonetheless, since the Illinois legislature can’t reform pensions, that leaves bankruptcy for eligible municipalities. The legislature can pass HB0298.

Considering the Governor’s long shot constitutional amendment, it doesn’t take a huge leap forward to realize that Illinois’ most viable approach to pension reform is municipal bankruptcy. After all, Judge Rhodes in Detroit and Judge Klein in Stockton both agreed that pensions could be impaired in bankruptcy. And, the State of Michigan has specific constitutional protections for pensions that are similar to Illinois’ protections. So while Illinois’ state law is not working particularly well, municipal bankruptcy appears to be an obvious option. It is not as if the state has the resources to fund a municipal rehabilitation or support programs for financially troubled municipalities – particularly when Chicago is considered. So, we can expect to see Illinois move forward with its Chapter 9 legislation — the Illinois Supreme Court has left the legislature with no other option.

Illinois now joins Oregon and Arizona as recent examples of high courts rejecting pension reform. Other states have upheld cutting benefits. Two states that come to mind are Colorado and Florida. Whatever approach a state takes with regard to pension reform is going to have an impact on options available to address municipal distress caused by escalating pensions and related retirement costs. When high courts reject reform, it is probably time to consider letting the federal bankruptcy courts apply the bankruptcy code and decide pension reform in the context of a plan of adjustment. That solution will have its own set of costs, not the least of which will be increased costs to access the capital markets. But, that is a blog for another day.

Stay tuned; we are far from finished with municipal distress, pensions, chapter 9 and complicated issues of constitutional law.